Managing for a predetermined profit is not a well-known practice in the construction industry, where smaller companies, including startups, owner-operated organizations and small partnerships represent the majority of firms. Yet, when put into practice and administered consistently, a predetermined profit plan can be quite advantageous for construction firms of all sizes.
Historically, small construction companies tend to be very lucrative when their sales volume is low and they have control over expenses. For example, take a contractor with five full-time employees doing business at the rate of $1 million annually. This contractor can easily manage a predetermined goal of a 20 percent yearly profit. That’s because the contractor is able to manage not only costs, but also all other business variables affecting this rate of return. The contractor determines the number of projects undertaken by the company and only accepts those that meet or exceed the established goals. The company’s low supply-and-demand pipeline is easily filled by the company’s exclusivity, making it easy to achieve and manage the required 20 percent predetermined profit.
Now consider another example. Take the same small construction company 10 years later. They have 10 times the business volume, 50 employees and $10 million in sales annually. It sounds like the company is doing well. Unfortunately, its sales are reduced to five percent profitability due to fair market pricing, marketing expenditures and sales commissions. Once the percentage of error due to mismanagement is accounted for, this company is now clearing zero percent on the $10 million.
Unfortunately, this example is common. As companies grow in size and structure and management becomes stretched, the percentage of profitability often declines.
A plan defined
A predetermined profit plan is a clear and concise written action plan that details how owners and managers work together to achieve the company’s minimum profit requirements. While a predetermined profit plan and an organization’s budget are intertwined, the predetermined profit plan is more than the net income left at the conclusion of a fiscal year. Instead, it is a plan that drives all the company’s activity so that budget requirements are met and profit expectations are realized.
The first step in creating and managing a predetermined profit plan is to determine the sales and profit goals based on historical company information, risk and growth, the health of the industry and the economy. The sales goals dictate the levels of performance required in all departments to achieve goals.
The second step is to develop the company’s performance measures. These are the heart of the company. They represent the activities and processes that drive the company’s profitability and ensure success of the company.
Accordingly, it is essential for owners and managers to work together to identify these processes so that they have accurate and timely data abut how profitable the company currently is and what is necessary in order to reach the goals for future performance. To stay on top of the profit outcomes, these processes need to be quantifiable so they can be measured and tracked weekly. Consistent tracking will ensure that improvements in the processes can be initiated in a timely manner to produce the desired sales and profit results.
The third step is managing to the predetermined profit plan. Ideally, owners and key managers meet weekly—or minimally, monthly—to asses the progress toward goals. Depending on the company’s financial structure, this assessment can be easily accomplished by generating targeted reports with the financial software, such as flash report capability via QuickBooks. Then, leaders can quickly make course corrections if the measures aren’t achieving the desired results and thereby avert any major surprises and disasters. With a hands-on approach, owners ensure that the predetermined profit plan will produce the desired financial results.
Example from the field
Andersen Windows and Doors is one of the best known and largest manufacturers of windows and doors, even though the public tends to view the company’s products as more expensive than most. Yet, due to savvy marketing campaigns, Andersen Windows and Doors also is regarded as one of the best manufacturers in the business. When the housing bubble burst, Andersen had much to lose, including profits. Through management’s constant monitoring of marketing conditions and costs, as well as profit levels, the company was quick to respond. Although new construction was almost 100 percent of its business, Andersen withdrew from new construction projects almost immediately. But it did so strategically by adapting and reinventing itself. Andersen accomplished this by going into the replacement and renovation sector of the industry. The company created a franchise of high-priced composite replacement windows called, “Renewal by Andersen.” In addition, Andersen made a strategic acquisition of a $99 million vinyl replacement window company in New Jersey called Silver Line Building Products Corp., now known as Silver Line, an Andersen Company. The addition of these companies allowed Andersen the ability to provide windows and doors for almost any new construction or home improvement project.
There are several critical skills owners can use to manage for a predetermined profit. These include:
- Intimately knowing the company’s expenses and costs;
- Using historical and realistic numbers— based on past and present performance— in creating the plan;
- Creating and using a customized budget with input form every department in the company;
- Involving all management staff in stabilizing costs and meeting profit projections;
- Using outside expertise to design the predetermined profit plan;
- Implementing a manageable predetermined profit plan and sharing it with the management team;
- Ensuring the management team knows daily where the company stands in achieving the goals identified in the profit plan; and
- Creating incentive-based profit systems to reward employees when they meet the profit numbers.
Applying these skills allows companies to avoid the pitfalls of staying within budget without turning a profit. It may be difficult for those working in larger organizations to believe that their contributions really affect the company’s bottom line. However, when organizations employ strategies that tie employees’ job duties to corporate goals, they will see how their pieces fit into the organizational profit puzzle.
Eye on the target
Too often, upper level managers lack the day-to-day supervision of critical data, information and vital performance measures. That’s because they are so close to the top of the organization and tend to have tunnel vision. Also, in most multi-departmental organizations, typically managers are responsible only for their own department’s profits. It’s easy to see how lapses in profit may go unnoticed when managers are worried only about their own area of responsibility and not the bottom line.
That’s why a written plan that details the steps for managing a predetermined profit plan can mean the difference between failure and success. It provides a systematic method for ensuring that owners and managers are on the same wavelength, are committed to a unified team effort and are confident they are in control of the company’s profitability.